Interest Rate Risk over the Life-Cycle: A General Equilibrium Approach

Toke Ward Petersen

No 200103, DREAM Working Paper Series from Danish Rational Economic Agents Model, DREAM

Abstract: This paper examines the consequences of introducing an idiosyncratic uncertain interest rate in a standard life-cycle model à la Auerbach and Kotlikoff (1987). Since the labor market has no uncertainty, labor earnings are used by the consumers to compensate for the risks in the capital market. The multi-period general equilibrium model introduces the possibility for consumers to adjust their labor supply ex post in response to new information becoming available (in addition to the opportunity to hedge ex ante). Increased uncertainty causes the number of hours worked to increase, since some old agents start supplying labor to compensate the poor performance of their savings. The framework also makes it possible to quantify the value of labor supply flexibility for these old agents.

Keywords: idiosyncratic interest rate uncertainty; labor supply flexibility (search for similar items in EconPapers)
JEL-codes: D58 D91 H2 (search for similar items in EconPapers)
Pages: 24 pages
Date: 2001-09
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:dra:wpaper:200103

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